The hidden economy represents a significant challenge for many countries around the world, including Bulgaria. In the context of globalization, measures against it are becoming increasingly relevant and necessary. For example, the size of the unregulated sector in Bulgaria is one of the primary reasons the country remains on the so-called grey money laundering list of the Financial Action Task Force (FATF), where it was placed last year. This placement indicates that Bulgaria is under increased scrutiny for money laundering activities, causing significant difficulties for Bulgarian businesses operating internationally.
A report prepared for the European Parliament's FISC Subcommittee on Tax Matters reveals that Bulgaria had the highest proportion of the hidden economy in the EU, accounting for 33.1% of GDP in 2022. On the one hand, informal practices are linked to turnover evasion, tax avoidance, and VAT fraud, but on the other hand, they rely on the non-declaration of labour. For those working in the informal sector, job security and workplace safety are compromised, and they are deprived of their full pension, health insurance, maternity leave, and even annual leave benefits. The COVID-19 pandemic has also created opportunities for abuse of employment rights and short-term financial support schemes. According to the latest CSD survey among 1,051 adults conducted in October 2023, 11.8% of the population do not have a written contract with their primary employer (compared to 4.8% self-employed and 3.9% business owners). Additionally, 20% admitted that their actual pay from their main job was higher than what was stated in the contract. A significant proportion of workers conceal income in various ways: 10.5% are insured at the minimum social security threshold despite receiving higher total remuneration, and 12% report a lower amount in their contracts than their actual pay.
Prerequisites
The hidden economy is closely linked to corruption. Empirical studies show that the two have a symbiotic relationship - a one-point increase in the corruption index is associated with a 0.253% point increase in the level of the hidden economy (as a percentage of GDP). Thus, it can be concluded that the hidden economy and corruption are both a result and a symptom of bad governance.
Evasion of taxes and social security payments is often driven by the motivation to compensate for the lack of quality public goods while simultaneously maximizing personal profits. In addition to corruption, the hidden economy also thrives due to a generally weak institutional and regulatory environment, insufficient capacity of public authorities, and low awareness of its negative social consequences.
For example, the National Statistical Institute (NSI) reports that in the first quarter of 2024, 29 000 people have been unemployed for 12-23 months, while 49 500 people reported being out of work for two years or more. Furthermore, according to the latest Eurostat data, youth unemployment (under the age of 25) in Bulgaria reached an alarming 16% in March 2024. According to CSD analysis and estimates by the National Employment Agency (NEA) in Bulgaria, youth unemployment is due to a number of factors: the late age at which young people leave their parents' households; the low level of labour mobility; and the weak social and economic development of some regions in the country. Data from Eurostat analysis further reveals that a large proportion of unemployed young people in Bulgaria come from socially vulnerable groups - women, ethnic minorities and people with disabilities.
Countermeasures
A deterrent effect can be achieved by optimizing the methods for identifying firms and sectors operating in the informal economy and concentrating checks and inspections in these areas. Additionally, consideration could be given to increasing fines, more frequent closures of businesses where serious infringements have been identified, and the use of blacklists to prohibit non-compliant businesses from applying for national and EU funding. Bulgaria has a good practice in this respect: employers who allow work without an employment contract lose the right to participate in public procurement for three years from the date of the penal decree's entry into force, regardless of whether they have paid a fine. Similarly, Croatia provides some examples of good practice, as the state maintains a list of companies that do not pay their workers. However, in order for the policies countering the informal economy in Bulgaria to have optimum impact, the public authorities should first:
- Develop common databases that consolidate information from the Registry Agency, the National Social Security Institute, the National Revenue Agency (NRA), the Employment Agency, information on enterprises providing temporary work, etc. Belgium offers a good example of such an approach, whereby the Crossroads Bank for Social Security (CBSS) combines data from 14 state institutions (national and local social security, safe working conditions, pensions, family benefits, etc.). It is also important to collect information from whistleblowing reports in common databases.
- Establish an effective risk assessment procedure based on an analysis of available databases. For this purpose, several key risk indicators need to be defined and monitored, such as: whether all workers in a firm are working at minimum wage, whether a firm has low wages but high profits and food and transport costs, whether the firm's turnover is below the minimum for the sector/size of the firm, whether there is low profit combined with high investment in non-productive assets, high proportion of part-time employees, high staff turnover, or "circular" posting (borrowing workers between the same companies).
- Representatives of trade unions, business associations and other stakeholders, e.g. those working to protect the rights of migrants and refugees, should also participate in inspections. Furthermore, it is important to monitor several types of violations during inspections - illegal and/or undeclared work, labour exploitation, non-compliance with safe working conditions, hiding profits, and VAT fraud.
- Inspections and subsequent punishments should not be used only as a repressive method. They should be accompanied by an explanatory campaign, such as the example of the Belgian Social Security Agency's website, which answers the question "What can an inspector check?" It is recommended that companies receive prior notification that there are doubts about its activities before a desk-based or on-site inspection takes place, giving it the opportunity to correct its behaviour. Sending similar notification letters about detected potential irregularities is a standard practice in countries like Spain, Estonia, or the UK, for example
More information can be found in the good practice library of the European Platform against Undeclared Work of the European Labour Authority, where Bulgarian institutions are also represented and actively involved.
Prevention
Prevention can be achieved through simplification of procedures, tax breaks, a smooth transition to self-employment and/or the creation of new categories of work (such as the one-day contract in Bulgaria). Good practices in the EU include the granting of amnesty (waiving part of the obligations) for voluntary disclosure of information and the formalisation of a company, as well as the establishment of information centres providing support and advice to start-ups. A change in values and norms can be achieved through better tax education and awareness raising.
However, despite the existence of similar initiatives, information and awareness-raising campaigns on the subject in Bulgaria do not always reach everyone. The impact of these campaigns would be greater if they were conducted annually through various media, including videos, brochures, and mobile apps. In Bulgaria, for example, a video could be distributed on the metro, television and social networks, similar to the one used in Norway making viewers aware of the concerns of a mother from Poland whose son is a truck driver in Norway. In Finland, there is a calculator that allows workers and employers (especially if they are foreigners) to calculate the net and gross value of pay, including what taxes and social security contributions are due on bonuses and other types of additional pay. The UK has an online platform through which citizens can check whether they are working in the grey sector and what they could be penalized for. In certain EU countries, another practice of carrying out information campaigns on the streets sees stalls and tents set up where passers-bys could obtain more information about their employment rights. A different approach is also needed for sectors that traditionally have a high share of informal economy - tourism, agriculture, and construction. For example, countries such as Belgium, Lithuania and Iceland have adopted the practice of allowing workers on construction sites only after marking special cards or QR codes for identification. These cards contain encrypted information on the status of the employed or self-employed worker and the type of contract on which he or she works. These cards greatly facilitate on-site inspections by public authorities.
Tackling cross-border undeclared work
Undeclared employment can be observed both in Bulgarians posted abroad and in foreigners from the EU or third countries who come to work in Bulgaria. Refugees and migrants in Bulgaria remain an untapped labour resource that is also at risk of exploitation. In addition to the effective implementation of the European Posting of Workers Directive (Directive 96/71/EC) and Regulation (EC) No 883/2004 on the coordination of social security systems, the signing of bilateral agreements and Memoranda of Understanding between Bulgaria and other EU Member States could significantly assist the process of tackling cross-border undeclared work. For example, Belgian legislation allows its inspectors to use evidence obtained from another country that has signed such an agreement. Unfortunately, this is not the case in other EU countries.
What are the new risks?
In recent years, the development of IT technologies has introduced new risks that necessitate additional countermeasures. These risks include, for instance, cryptocurrency payments and online platforms that offer services from multiple users without declaring fees. Greater attention should also be given to methods related to identity theft. The misuse or theft of identities can facilitate various schemes aimed at 'legalizing' undeclared or illegal workers lacking work permits, creating 'ghost employees' on payrolls to justify tax deductions, and generating profits for owners by reporting wages of these 'ghost workers' or pension claims. Moreover, identity theft can be used to establish fake companies involved in invoice fraud and VAT evasion.
The article is published in Manager magazine.